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June 6, 2011

Five Misconceptions About QE2’s End

When QE2 ends on June 30, buying pressure for stocks will take a hit.

On the surfaceBen Bernanke is trying to promote a new and transparent Federal Reserve. His first ever post-FOMC meeting news conference answered some questions about the future of quantitative easing (QE), however, many dangerous misconceptions remained on the table.

1) Inflation

Bernanke continues to deflect any responsibility that QE has resulted in inflation caused by energy and commodity prices. Ironically, Bernanke does concede that more QE will result in more inflation.

Obviously, there’s a broken track in this train of thought, particularly since inflating stock prices is the intent of QE2. If QE lifts one investable asset, stocks, why wouldn’t it lift another?

2) The Dollar

The first two months after QE2 launched in early November the U.S. dollar was rising. Since then,it’s been falling.

I’ll leave it up to others to debate whether QE2 sunk the greenback or not but I will gladly point out the flawed reasoning behind Mr. Bernanke’s claim that the Fed is stabilizing the U.S. dollar by limiting inflation. Excuse me, but trying to contain the inflation you caused does not qualify as a step towards strengthening the U.S. currency.

3) Treasuries

It's logical to assume that demand for U.S. Treasuries will dry up when QE2 comes to an end. However, QE2 was supposed to lift Treasury prices and reduce interest rates.

The opposite happened. Since QE2 was introduced, the iShares Barclays 20+ Year Treasury ETF (TLT) dropped from 101 to as low as 88. 30-year Treasuries topped and rolled over on August 25, 2010.

On that very day, the ETF Profit Strategy Newsletter warned : “Technical analysis along with fundamentals suggest thatT-Bonds are getting ready to roll over. A look at the overall picture suggests that this is more than just a minor correction.” From nearly 110 on August 25, TLT dropped as low as 88.

4) No More QE2

QE2 will end on schedule in June. Since inflation is prohibitive, there is no QE3 planned. However, the Federal Reserve will continue to reinvest the proceeds of maturing securities it already owns.

Mr. Bernanke didn’t reveal exact numbers, but based on the Federal Reserve’s website this will amount to about $20 billion per month (compared to about $100 billion per month under QE2).

5) Financial Markets

According to Bernanke “the end of the program is unlikely to have a significant effect on the financial markets.” To understand what the absence of QE means for stocks doesn’t take much guesswork or imagination.

A) We saw what happened to stocks last year when QE ran out in April.

B) We saw what happened when seeds of hope for QE2 were planted in the summer.

So, what will happen when QE2 ends on June 30? No doubt buying pressure for stocks will take a hit.

On May 2, the S&P recorded its 1,370 recovery high. This high is just one point above important Fibonacci resistance outlined by the ETF Profit Strategy Newsletter back in March.

This Fibonacci resistance at 1,369 marks the lower end of an ideal target range for a major market top. The higher end is comprised of another Fibonacci resistance and coincides with a multi-decade trendline and bearish chart formation.

We don’t make up such powerful resistance levels, the market does.

***
(The ETF Profit Strategy Newsletter identified the upper target range of this rally, and in case this target won’t be reached, it highlights the one support that needs to hold to keep the bullish potential on the table. The newsletter provides updates every Sunday with at least one mid-week follow up.)

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